Suppose you could simply plug a software code into your brain and instantly trade like the top traders of all time. Sadly, such a capability is not within our grasp, unlike Neo in The Matrix. Nonetheless, the underlying lesson to be learned here is profound, and today we wish to impart it to you. To make money as a trader, you must think and act in a certain way.
The world’s greatest traders, whether by instinct or through experience, understand that your brain can deceive you to such an extent that you may not even realize it is happening. Given that you cannot upgrade yourself like Neo and become part machine, your task is to train your more advanced and highly-evolved cognitive processes, so that the more primitive brain functions do not take over and impede your trading success.
Initially, you must understand the following two brain systems:
The brain is composed of distinct components, each with their own specific functions. Some pieces are geared towards fulfilling our primal needs, such as hunger, affection, and other pleasurable activities. These parts are the oldest and often hold the initial sway over most decisions, which can prove problematic for traders. Most traders tend to allow these older brain parts to dominate, even without realizing it. Consider, for instance, the sensation of viewing a chart that’s aggressively trending in a particular direction, causing your heart to race as you are eager to enter a trade in that direction. This is an example of your primal brain functions taking control.
Essentially, the brain serves two fundamental purposes: primitive functions like fight or flight, rewards/urges, and more advanced functions like planning, mathematical reasoning, and cognition. As traders, it’s critical that we learn how to harness both brain functions in harmony to achieve the most favorable outcomes.
Reflexive brain system
In his book “Your Money & Your Brain – How the New Science of Neuroeconomics Can Help Make You Rich,” Jason Zweig discusses the Reflexive brain system – the older components of the brain mentioned earlier. This system operates so rapidly that you often respond before your conscious brain even registers that there was anything to react to! For instance, you might instinctively swerve to avoid a hazard on the highway before you can even identify what it is. The Reflexive brain system typically takes the lead in making most judgments and decisions, which, as previously noted, can lead to disaster for traders.
In essence, the Reflexive brain system is all about intuition and emotion. This is not to say that these factors are always detrimental; in fact, I have written articles on utilizing a trader’s intuition. Later on, we will explore how and when to employ your reflexive trading intuition effectively, and when to avoid it.
Reflective brain system
The Reflective brain system serves as a counterbalance to the Reflexive system. This component primarily resides in the prefrontal cortex, situated behind the forehead, and constitutes the most sophisticated and recently developed segment of the brain. Neurons in this area are intricately linked to the rest of the brain and derive overarching conclusions from scraps of information, arrange past experiences into recognizable groupings, develop theories about the causes of environmental changes, and plan for the future.
According to Zweig, the Reflective system is chiefly utilized to tackle and resolve more intricate problems, such as “Is my investment portfolio sufficiently diversified?” or “What should I get my wife for our anniversary?”
Too much of anything isn’t good for you…
Excess of either the reflexive or reflective brain systems can result in a continuous string of trading losses. While relying solely on the reflexive brain system can lead to impulsive and emotional decisions, which is akin to gambling rather than trading, overusing the reflective brain system can lead to over-analysis and analysis paralysis. Traders who overthink the market may miss out on good trades or convince themselves that they are correct about a trade, leading to the temptation to invest their entire account in a single trade, which is extremely dangerous and could result in a financial disaster. As the old adage goes, too much of anything can be detrimental, and the same is true when it comes to the usage of the different parts of the brain while trading.
How to trade as though you’re half a man and half a machine:
To excel in trading, one needs to strike a balance between human emotions and machine-like objectivity. Machines, like robots, operate without emotions and follow binary logic, much like the reflective system of our brains. Humans, on the other hand, are often driven by feelings and emotions, which stem from the reflexive system.
The key is to harness the power of both brain systems and not let one dominate the other. Consider exercise as an example: You may have an emotional desire to get in shape and achieve a specific result, but the physical discomfort and pain can often be overwhelming and cause many people to give up. However, if you push through and remain consistent, you can eventually start to enjoy the exercise and the rewards that come with it. This requires a balance of both the reflexive and reflective brain systems. The reflexive part of your brain rewards you with endorphins, strength, fitness, and better health, while the reflective system drives your commitment and discipline to achieve your goals.
Here’s the key takeaway for successful trading:
Avoid the lure of quick profits by refraining from over-trading and over-leveraging your account, and sticking to your trading plan. This requires minimizing the use of your reflexive brain system. Instead, use your reflective brain to plan ahead, with the understanding that discipline and consistency now will lead to long-term payoffs. Do not act impulsively when you spot a potential trade, but rather use a trading checklist to compare it against your trading plan. Take a deep breath and think through your decision before making a move. Take breaks and step away from the computer screen after trades. It’s important to use your intuition, but also to balance it with your reflective brain system to make informed decisions.
In the Matrix, Neo knew something was wrong in the beginning; he figured out he was stuck in the matrix that was causing his brain to be flooded with feel-good computer simulations that over-stimulated his reflexive brain system, which was keeping everyone obedient to the architects of the matrix. Neo wanted more though, he wanted the truth, and when he finally woke up from the matrix he was then using his reflective brain system in addition to his reflexive system, and that is when he really flourished. You must be like Neo in the markets, with your trading. You must realize that if you are not proactive about it, you will naturally end up using your reflexive brain systems too much, and this is indeed what most traders do and why they lose money. You must ‘unplug’ from the ‘Matrix’ that is acting on your first impulse and just following your urges and what ‘feels good’ in the market. You cannot make money trading this way. It’s hard to over come at first, but just like exercise, it gets easier and more rewarding over time, it becomes reinforcing. To learn more about this and to get started with a plan of attack that will get you on the right path, check out our advanced trading course for more in-depth training and information.